Summer heat ignites form-filing requirements
The tax landscape was charged up in June as the filing deadline for foreign bank accounts and other financial account disclosures drew near.
Earlier this year, I commented on the recent effort by the Internal Revenue Service to step up its enforcement and taxpayer compliance with foreign account reporting on Treasury Department Form 90-22.1, referred to as FBAR. I mentioned the IRS had tightened some of the offshore account reporting requirements and revised the definitions included in the filing instructions.
Due to confusion about the new requirements and defining of terms within some of the guidance, the IRS announced June 5 that it is temporarily suspending some of the changes to the rules for certain foreign persons doing business in the U.S. and their need to report foreign bank and other financial accounts on the FBAR form.
Many tax professionals cheered at the announcement as it provided time for the IRS to better define what persons are required to file the form. In addition, practitioners still had questions, so the IRS scheduled a conference call with representatives from the memberships of the American Bar Association and the American Association of Certified Public Accountants to address some of the questions that have been raised in recent months and to provide further guidance with the voluntary compliance programs announced on March 23 for taxpayers that should have filed but had not filed the FBAR form for prior years.
The June 12 conference call created more confusion than clarity in many respects. The IRS attempted to clarify its interpretation of certain filing requirements and in the end raised some issues, which resulted in expanding the filing base of taxpayers that may have a filing requirement for the form. This resulted in a mad dash to try to comply with the June 30 filing deadline.
The filing deadline and who needs to file are critical elements of the reporting process for foreign accounts. Both civil and criminal penalties may apply for failure to file or comply with the filing requirements. The aftermath of the June 12 call was that most tax professionals interpreted the IRS guidance in answering questions that a filing requirement may be required for many investors in private equity, venture capital and hedge funds that had offshore investments. In recent years, many individual and corporate taxpayers, institutions including foundations and pension plans and others had made investments in partnerships that held non-U.S. investments. The structure of the investment funds or partnerships created a situation whereby the investors of the funds may have a filing requirement.
The guidance that investors in private equity, hedge funds and similar investments may have filing requirements sent shockwaves through the tax and investment community. Most had not anticipated this position, and they raced to obtain the required information from the funds and file within days before the June 30 deadline.
The filing confusion can be attributed to several factors. For a number of years, the form was commonly referred to as the foreign bank account reporting (FBAR) form. However, it actually required the disclosure of foreign bank and financial accounts. The FBAR form was revised in October 2008 and expanded the definition of financial account to include a foreign mutual fund. The term “mutual fund” was not defined directly or by any cross reference to the Internal Revenue Code or a term used by the Securities and Exchange Commission or any of the securities and exchange acts. Thus, it was left to some interpretation and had different meanings to different individuals. Of course, the opinion that counted most was that of the IRS, which was charged with the task of carrying out the administration of the filing of the Form TD F 90-22.1.
On the June 12 call with the ABA and AICPA, the questions and answers provided left tax professionals with the understanding that foreign accounts may actually include offshore managed accounts that have commingled investments. Hence, the need to consider whether offshore hedge funds, private equity funds and venture capital funds with U.S. investors were not subject to the FBAR reporting that foreign bank account holders are subject to.
The universe of offshore investment through funds that may be affected and require a filing of the FBAR form is quite broad and includes: domestic feeder funds that have an investment in an offshore master fund; U.S. persons that invest directly in an offshore feeder fund; and investment managers and general partners (and their principals) who have an equity interest in an offshore fund (including a profits interest). This universe of investments being caught in the spider web of the foreign account reporting requirements caught many off guard. The possible criminal penalties for non-compliance struck more fear than a venomous spider.
With the IRS clarification of the types of investments that may be reportable on the FBAR form, many taxpayers will become or have become first-time filers. The list of potential filers includes many entities generally considered to be tax exempt. This new list includes foundations, exempt trusts such as charitable remainder trusts, retirement accounts (including IRAs, and pensions), nonprofit entities, and other entities that may have made investments in partnerships or funds with offshore activity.
On June 24, the IRS issued an updated FAQ list for potential filers and their advisers. It may provide some limited ability to defer a FBAR filing until Sept. 23, 2009, if there is reasonable cause involved with respect to the timing of the late filing.
The IRS made it clear that this is not an automatic extension, just the ability to request a waiver or abatement of any possible penalties for late filing under the reasonable cause exception.
The IRS has also recently indicated that additional guidance and clarification will be provided later this year, given some of the uncertainty in the interpretation of the instructions and the scope of their application. It is likely that many filings that have been filed may not be necessary once the rules and guidance are finalized. Perhaps that new guidance will be more specific. Unfortunately, for the current filing season, that guidance will be too late. The enforcement of the final rules will be enhanced with the Obama administration’s proposals in May to add another 800 employees for the IRS to increase administration and enforcement of foreign accounts reporting. With the recent changes and current proposals, it is clear that there is dedicated focus on offshore reporting and tax policy.
William Roth is a tax partner with BDO Seidman LLP. The views expressed are those of the author and not necessarily those of BDO Seidman.